Markets Spring 2022
In the first quarter, the S&P 500 Index corrected intraday 14.9% from its high, and on a closing basis 13% implying that the U.S. economy is in a growth scare rather than an impending recession. By quarter end, a broad rally in stocks recovered more than half this correction losses. This was the worst correction since the start of the Covid pandemic two years ago. A faster tightening cycle by the Federal Reserve, runaway inflation and Russia’s invasion of Ukraine all contributed to the stock market’s correction.
The S&P 500 could retest current correction low if inflation does not peak in Q2. Parts of the Treasury yield curve inverted, typically a harbinger of a recession ahead. The yield curve subsequently quickly un-inverted to a positive sloping curve making an argument for growth ahead not a recession. The 3 months-to-10-years Treasury Yield Curve, a more reliable indicator, remains steep signaling no recession ahead. Which way the market goes depends on the path of inflation. If the Fed through its front-loaded hikes cannot curb inflation soon then expect a recession and down market in stocks over next twelve months. Furthermore, weighing on stocks is the upcoming Mid-term election. Historically stocks correct sometime from May through October period before Mid-term election.
The bottom line, this will be a transition year for the U.S. economy but worth the pain. Does anyone really expect that transitioning from abnormal monetary policy (zero Fed Funds rate in an economy that grew at 5.7%) to more normal monetary policy will happen smoothly? In the end the U.S. economy will be better off with normal yields and rates and so will income investors.
There may be room for investors to gain from stocks later this year. The S&P 500 typically peaks 18 months after an inversion and a recession typically starts shortly after that – late 2023. It takes around a year for stocks to peak after a point of the Yield Curve inverts, and the S&P 500 usually trades higher by 15% during that period, according to JPMorgan. Following the Midterm election, this November through April 2023, S&P 500 enters its historically best return period of the Presidential cycle, with past returns strongly positive one hundred percent of the time according to the Stock Trader’s Almanac. Given inflation recedes and U.S economy avoids a recession, stocks would rally. For the time being, I am only buying stocks at lower entry levels than today’s market level. I expect to be overweight stocks again before Midterm election day.